Business Leases: |
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Whether a business is new or well-established, as long as property must be leased from someone other than the business owner, the lease is a critical document for the business.
The lease should be approached not only as a legal necessity, but as a business issue affecting the entire business. The lease and the many issues covered within the lease agreement determine the location, image, growth capacity, moveability, saleability, and financial burden of the business.
Aspects of the lease which are not important now may become important later, especially in a long term lease. Consequently, it is important to consider all aspects of the lease, and all circumstances that may affect the business during the term of the lease. If one's business is not predictable, it is more important to consider various possibilities. Consider the changes that might possibly affect the business and whether or how to treat these possibilities in the lease.
Make sure you consider and negotiate all elements of the lease. Don't fixate on one or two aspects of the lease, no matter how important they are. Even the most important aspects of location and rent must be weighed against other aspects of the lease.
The following are just a few of the many aspects of a lease to review carefully:
Location. Consider what type of location is necessary for this type of business. Don't pay for an upscale location for a downscale business. Make sure you are comparing several locations at the same time. A lease, like anything else is "good" or "bad" only as it is compared to other alternatives.
Check the zoning and other regulatory requirements that would affect the operation of your business at a particular location. A common problem for small businesses in large cities is parking requirements. Find out early in the process if there are problems for your type of business with zoning at a particular location.
If you are told that the city will waive or reduce the zoning requirements, find out what the cost, effort, timing and likelihood of such an action would be. Some processes are simply too expensive or effort-consuming for a small business. Don't get caught up in such a process if finding a different location is a better plan.
In California it is also important to find out how much the city business license fee (tax) is for your type of business. Since many California cities have a city business license fee which is determined as a percentage of gross revenue, this fee can be quite a problem for small businesses.
Rental amount. A tenant must pay not only the monthly rental amount, but also any additional expenses the tenant is made responsible for under the lease. Business owners need to be warned to carefully review all lease terms to discover all expenses the tenant is required to pay.
Don't accept characterization of a lease as a "gross lease" or general statements by the landlord or the broker that additional costs are "minimal." Make sure you know from the lease provisions what expenses you are required to cover as tenant.
A lease may require tenants to pay all costs relating to the property or the increases in operating costs after the year the lease is entered into. If the landlord will control building maintenance and repair, tenants can unexpectedly be required to pay for projects controlled by the landlord, such as repaving parking lots, reroofing, and plumbing.
In negotiating a lease, the tenant must obtain information to independently estimate what the total costs of all expenses passed on to the tenant might be. Other tenants should be questioned about what they have paid and the condition of the building should be determined. The tenant should negotiate a cap on the tenant's payment toward such additional expenses. Having even a high limit is better than no limit at all.
Insurance. Get quotes on the insurance required by the lease before you negotiate the lease. You may not be able to get some of the insurance, or the premiums for the insurance requirements may be too high. Knowing this in advance will make it possible to modify the insurance requirements. To enter into a lease and then not get required insurance means you are in default and may have the lease terminated unless you obtain the required insurance or negotiate (at a severe disadvantage) new insurance terms.
Improvements. Make sure that all improvements are planned and covered in the lease. Most leases prohibit any improvements or modifications unless they are approved in the lease or in writing later by the landlord. Don't wait until your negotiation power is gone. Once you are a tenant under a lease, the landlord has no incentive to make improvements or approve improvements that were not included in the lease.
If improvements are to be made by the landlord, make sure even small details are stated in the lease or in exhibits attached to the lease and referred to as part of the lease.
Options. Every tenant should try to get an option to extend the lease at the end of the term. An option is often very one-sided. The tenant may or may not choose to exercise the option and extend the lease. If the location, rental amount, and option terms are attractive, the tenant will want it. If the option is not attractive the tenant will not exercise it and will be free to let the lease expire. Because of the tenant's power in this situation, any option is better than no option.
An option which extends the lease without an increase in rent is particularly valuable. Some lease options make sure the landlord gets market rate rents in the lease term as extended by the option. Even this type of option is beneficial to the tenant. Almost any option is good to have.
Sublease. Most leases require the landlord's consent to any sublease, and many explicitly provide that a proposed subtenant must meet certain financial criteria to be approved. The lease may provide that the tenant must pay for the costs of reviewing and approving a subtenant.
If you intend to sublease part of the property either from the beginning, or later if financially necessary, the lease provision covering subleasing must allow you to sublease without expensive obstacles.
Inflation Increases. Many leases today contain a provision for increasing the rental amount by the amount of inflation. A common provision uses the Consumer Price Index ("CPI") published by the Bureau of Labor Statistics, U.S. Department of Labor, to gauge inflation and increase rents.
Using a formula to determine the rental increase is a far better approach than trying to deal with inflation by automatic rent increases over the term of the lease. Although the CPI can be criticized as inexact and overstating inflation, it is at least based on inflation and lease increases based on the CPI will generally track inflation. The rent increases then will be generally the same as other increases in business expenses, which can be passed on by the business tenant to its customers.
New Business
The new business faces somewhat unique issues in negotiating a lease. While the established business has the benefit of greater certainty that it will survive, and of knowing what type of facility and location is necessary, the new business is challenged to identify the right type of facility and the right type of lease.
The new business needs more flexibility. It may grow, or change, requiring additional or even different facilities. It is usually much more cautious about total lease payments. Yet it must avoid making the mistake of renting the wrong type of facility because it is cheap.
Ideally, the new business should want a very short lease with numerous options to extend the lease, with low lease payments, and with no responsibility to handle or pay for repairs and maintenance. Such a lease is difficult or impossible to negotiate. And a new small business is often not able to negotiate the best terms. A landlord usually wants the opposite of what the business tenant wants, and is usually more motivated to give concessions to financially strong, established businesses entering into long term leases.
Negotiation
Don't underestimate the importance of the negotiation process. Prepare your negotiation strategy before you even make contact with the property owner. Make sure you have alternative properties to consider and compare to.
Don't put yourself in a poor negotiating position. For example, if you have an established business, you can't wait until your current lease is almost up before negotiating a new lease. You don't have much negotiation power when it is apparent that you have not planned ahead and that you will have to sign a lease or move.
Don't neglect to deal with issues that must be covered in the lease. After the lease is signed, don't count on getting one more favor or benefit from the landlord than what's clearly set out in the lease.
Your strongest negotiation power is after the landlord has determined that you are a desirable tenant but before you sign the lease. Do not fail to negotiate your best deal at this time.
(c) Copyright 1997 Mary Hanson. All rights reserved.
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Mary Hanson, MBA, Attorney at Law (310) 543-1355 Torrance (Los Angeles County), California USA